Finance 3

Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would shift in this manner: a. Down and have a steeper slope. b. Up and have a less steep slope. c. Up and keep the same slope. d. Down and keep the same slope. e. Down and have a less steep slope.

a. Down and have a steeper slope.

Which of the following is NOT a diversifiable risk? a. Inflation b. the risk that the CEO is killed in a plane crash c. the risk of a key employee being hired away by a competitor d. the risk of a product liability lawsuit

a. Inflation

Based on historical data, which of the following statements is FALSE? a. On average, larger stocks have higher volatility than smaller stocks. b. Portfolios of large stocks are typically less volatile than individual large stocks. c. On average, smaller stocks have higher returns than larger stocks. d. On average, Treasury Bills have lower returns than corporate bonds.

a. On average, larger stocks have higher volatility than smaller stocks.

For markets to be in equilibrium/efficient (that is, for all current information be incorporated into stock prices), a. The expected rate of return must be equal to the required rate of return b. The past realized rate of return must be equal to the expected rate of return. c. The required rate of return must equal the realized rate of return d. All three of the above statements must hold for equilibrium to exist. e. None of the above statements is correct.

a. The expected rate of return must be equal to the required rate of return

Which of the following statements is FALSE? a. The risk premium of a security is equal to the market risk premium (the amount by which the market's expected return exceeds the risk-free rate) divided by beta of the asset. b. Investors do not earn a risk premium for bearing unsystematic risk c. There is a linear relationship between a stock's beta and its expected return. d. A security with a negative beta has a negative correlation with the market, which means that this security tends to perform well when the rest of the market is doing poorly.

a. The risk premium of a security is equal to the market risk premium (the amount by which the market's expected return exceeds the risk-free rate) divided by beta of the asset.

"Risk aversion" implies that investors require higher expected returns on risky securities if they are to be induced to purchase them. a. True b. False

a. True

5. Is volatility a reasonable measure of risk when evaluating large portfolios? a. True b. False

a. True

A portfolio of stocks where each stock has a large component of idiosyncratic risk benefits when such stocks are held in a portfolio, because the idiosyncratic risks are averaged out. This is also referred to as diversification of risks. a. True b. False

a. True

Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific" events, and their effects on investment risk can in theory be diversified away. a. True b. False

a. True

If beta of Selleck & Company is negative, the CAPM would indicate that the required rate of return on Selleck's stock should be less than the risk-free rate for a well-diversified investor. a. True b. False

a. True

If investors are risk averse and hold only one stock, we can conclude that the return they would require on a stock whose standard deviation is 0.21 will be greater than the return required on a stock whose standard deviation is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the low standard deviation stock. a. True b. False

a. True

It is possible for a stock to have high total risk but low systematic risk. a. True b. False

a. True

You expect General Motors (GM) to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM) to be 1.9 over the next year. Also, you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over the next year. Which stock has more systematic risk? Which stock has more total risk? a. XOM, GM b. GM, XOM c. GM, GM d. XOM, XOM

a. XOM, GM

For each 1% change in the market risk premium, the investment's excess return is expected to change by ________ percent due to risks that it has in common with the market (systematic risk). a. beta b. alpha c. zero d. cannot say for sure

a. beta

Because investors can eliminate unsystematic risk "for free" by diversifying their portfolios, they ________ a risk premium for bearing it. a. do not require b. require c. are indifferent about d. none of the above

a. do not require

Many former employees at Enron, an energy trading and supply company, had a large part of their portfolio invested in Enron stock. These employees were bearing a high degree of ________ risk. a. unsystematic b. systematic c. market specific d. non-diversifiable

a. unsystematic

The S&P 500 index traditionally is a ________ portfolio of the 500 largest U.S. stocks. a. value weighted b. equally weighted c. chain weighted a. price weighted

a. value weighted

While ________ seems to be a reasonable measure of risk when evaluating a large portfolio, the ________ of an individual security does not explain the size of its average return. a. volatility, volatility b. the mean return, standard deviation c. mode, volatility d. none of the above

a. volatility, volatility

You have the following data on three stocks: Standard Stock Deviation Beta Stock A 0.15 0.79 Stock B 0.25 0.61 Stock C 0.20 1.29 As a risk minimizer, you would choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well-diversified portfolio. a. A; A. b. A; B. c. B; C. d. C; A. e. C; B.

b. A; B.

Portfolio A has one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B is by definition riskless. a. TRUE b. FALSE

b. FALSE

Is volatility a reasonable measure of risk when evaluating the investment in a single stock? a. True b. False

b. False

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT? a. Stock B's required return is double that of Stock A's. b. If investors becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. c. If investors becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B. d. If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.

b. If investors becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.

Which of the following statements is CORRECT? a. If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1) and the stocks have equal standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks. b. The market portfolio will have a higher beta than a single stock that has a beta of 0.5. c. If a stock has a negative beta, its expected return must be negative. d. The market portfolio will have a lower beta than a single stock that has a beta of 0.5. e. According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

b. The market portfolio will have a higher beta than a single stock that has a beta of 0.5.

Companies that sell household products and food have very little relation to the state of the economy because such basic needs do not go away. These stocks tend to have ________ betas. a. high b. low c. negative d. cannot say for sure

b. low

The risk premium of a security is determined by its ________ risk and does not depend on its ________ risk. a. systematic, undiversifiable b. systematic, unsystematic c. diversifiable, diversifiable d. all of the above

b. systematic, unsystematic

In the market portfolio, you can diversify away all _______ risk, but you will be left with ________ risk. a. diversifiable, unsystematic b. unsystematic, systematic c. systematic, undiversifiable d. diversifiable, diversifiable

b. unsystematic, systematic

Jane has a portfolio of 20 stocks, each stock has a Beta of 1.2; and Dick has a portfolio of 2 stocks, each has a Beta of 1.2. Assuming the market is in equilibrium, which of the following statements is CORRECT? a. Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio. b. The required return on Jane's portfolio will be lower than that on Dick's portfolio because Jane's portfolio will have less total risk. c. Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios. d. If the two portfolios have the same beta, their required returns will be the same, but Jane's portfolio will have less market risk than Dick's. e. The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.

c. Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios.

Which of the following statements is FALSE? a. The risk premium of a security is determined by its systematic risk and does not depend on its diversifiable risk. b. When we combine many stocks in a large portfolio (e.g., in the market portfolio), the firm-specific risks for each stock will average out and be diversified. c. Fluctuations of a stock's returns that are due to firm-specific news are common risks. d. The volatility in a large portfolio will decline until only the systematic risk remains.

c. Fluctuations of a stock's returns that are due to firm-specific news are common risks.

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.) a. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0. b. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. c. If the market risk premium increases by 1%, then the required return of a stock will increase by its Beta. d. The effect of a change in the market risk premium depends on the level of the risk-free rate.

c. If the market risk premium increases by 1%, then the required return of a stock will increase by its Beta.

Which of the following statements is CORRECT? a. The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. b. If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. c. The security market line is a graph of the expected return of a stock as a function of systematic risk (beta). d. The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks in the portfolio. e. It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, Rrf.

c. The security market line is a graph of the expected return of a stock as a function of systematic risk (beta).

You expect General Motors (GM) to have a beta of 1 over the next year and the beta of Exxon Mobil (XOM) to be 1.2 over the next year. Also, you expect the volatility of General Motors to be 30% and that of Exxon Mobil to be 40% over the next year. Which stock has more systematic risk? Which stock has more total risk? a. GM, GM b. GM, XOM c. XOM, XOM d. XOM, GM

c. XOM, XOM

Inflation, recession and high interest rates are economic events that are best characterized as being a. systematic risk factors that can be diversified away. b. company-specific risk factors that can be diversified away. c. among the factors that are responsible for market risk. d. risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers. e. irrelevant except to governmental authorities like the Federal Reserve.

c. among the factors that are responsible for market risk.

As we increase the number of stocks in a portfolio, the standard deviation of returns of the portfolio a. increases. b. remains unchanged. c. decreases. d. none of the above

c. decreases.

The market portfolio is the portfolio of all risky investments held a. in descending weights. b. in ascending weights. c. in proportion to their value. d. based on previous year performance

c. in proportion to their value.

Which of the following is NOT a systematic risk? a. Inflation b. the risk that the economy slows, reducing demand for your firm's products c. the risk that your new product will not receive regulatory approval d. the risk that the Federal Reserve raises interest rates

c. the risk that your new product will not receive regulatory approval

The beta of the market portfolio is: a. 0 b. -1 c. 2 d. 1

d. 1

Which of the following statements is CORRECT? a. An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. b. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. c. It is impossible to have a situation where the systematic risk of a single stock is less than that of a portfolio that includes the stock. d. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, welldiversified portfolio of stocks.

d. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well diversified portfolio of stocks.

The excess return is the difference between the average return on a security and the average return for a. Treasury bonds. b. a portfolio of securities with similar risk. c. a broad-based market portfolio like the S&P 500 index. d. Treasury bills.

d. Treasury bills.

As we add assets to a portfolio where the assets are held in equal weights, the benefit of diversification is most dramatic a. after 20 stocks have been added. b. when there are more than 500 stocks. c. when there are more than 1000 stocks. d. at the outset.

d. at the outset.

Which of the following statements is CORRECT? a. A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock. b. If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. c. If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. d. A stock with an above-average standard deviation must also have an above-average beta. e. A security's beta measures its non-diversifiable, or systematic, risk.

e. A security's beta measures its non-diversifiable, or systematic, risk.